A Rocky Road, But Profits Ahead

12/04/2008 12:01 am EST


John Rutledge

Founder and Chairman, RutledgeCapital, LLC

John Rutledge, chairman of Greenwich, Conneticuit-based Rutledge Capital, casts a wide net, shedding light on the global recession as well as upcoming opportunities around the world.

Q. John, are we at the bottom yet (in equity markets) and what do you see for world markets in the next 12 months?

A. The US economy has substantially worsened in recent months; and the US and global economies are now in the early stages of a significant recession.

In early 2007, the problem was confined to the leveraged loan market as banks revealed their $300 billion in toxic loan commitments to US private equity deals. This was an isolated capital market problem, which had not materially impacted GDP. But in September 2008, the safety of money market funds came into question, seriously frightening individuals into taking cash from their bank accounts, putting all spending on hold and hoarding cash. Since then, GDP has been in serious decline.

Ironically, beginning in March 2008, the Federal Reserve’s series of liquidity measures, designed to provide cash to troubled Wall Street institutions, made this situation worse. They sold Treasury bills simultaneously, withdrawing reserves from the banking system, resulting in less than a 1% annual rate of growth in bank reserves and the monetary base in the 12 months leading up to September 2008. Since the September crisis, both reserves and the monetary base have more than doubled, which will eventually solve the problem. But the Fed was very late to the party.

Q. In which areas of the world do you see the most potential in the next five years?

A. China and India are driving global growth. They are in the eye of the hurricane at the moment, due largely to forced sales from mutual fund redemptions, but that will pass and they will resume their role as leaders of global growth for the next five years. Vietnam, like other Asian economies, will benefit from manufacturers who are shifting capacity from China to lower-cost economies.

Wild cards: North Korea and Cuba, which should be the top growth performers in the world after they have been opened and assimilated into the global economy. I expect this to happen in the first term of Obama's presidency.

Q. As a visiting professor at the Chinese Academy of Sciences, as well as an advisor in Beijing, you see first-hand the developments in China. Which particular Chinese regions—or market sectors—do you believe offer the best near-term potential?

A: In previous years, manufacturing has made southern Guangdong province the main engine of China's growth. In the future, growth will be driven by the information technology, financial services, communications, and education sectors, which will benefit northern China, including Shanghai, Beijing, Tianjin, and Dalian, the center of China's call-center industry.

Infrastructure companies, including telecom and communications companies, will benefit from China's $600-billion stimulus plan. Technology companies will be encouraged to acquire assets and grow abroad to reduce China's $1.9 trillion of foreign exchange reserves. 

Q. Is the individual investor better off with exchange traded funds (ETFs) or mutual funds, rather than investing in individual stocks? And what asset allocation strategy would you suggest for an individual investor?
A. The cardinal rule of investing is to only invest in things you understand. Most investors simply do not have the time or resources to do adequate research on companies and sectors around the world. ETFs allow investors to benefit from global growth stories without taking excessive company or management risk, have low management expenses, and are tax efficient due to low turnover.

The best defensive strategy at the moment is to invest in large-cap US companies with global exposure and rising dividends. The Standard & Poor’s 500 large-cap index SPDRS (AMEX: SPY), with more than half its earnings outside the US, should be the first building block in an investment strategy.

IShares MSCI Singapore (NYSEArca: EWS) gives a stake in Singapore's fast-growing technology and financial markets; iShares MSCI South Korea (NYSEArca: EWY) captures Korea's leading technology position in the China market, and iShares MSCI Pacific ex-Japan (NYSEArca: EPP) captures China's growth by investing in Australia, New Zealand, Hong Kong, and Singapore. These markets are out of favor now, but will perform strongly when global growth returns.

Q. How do you think technology stocks will fare in the next 12 months? Do you have any favorites?

A. The global recession is hurting the performance of the technology commodity (microchip) companies. Branded consumer technology companies, like Apple (Nasdaq: AAPL), will fare much better.  Overall, I believe technology companies will outperform the market in the next 12 months.
Q. How will the US election outcome impact world markets and economies?

A. It could have a major impact, depending on which Barack Obama we get: the first one we met in 2004 that everybody fell in love with—the one who talked about the need for people to come together to solve the big problems, or the campaign Obama, who spoke about increasing taxes for wealthy families and big business and proposed implementing protectionist policies targeting China, India, and other foreign countries.

I am hopeful that we will get the first one back. If I'm right, he has the potential to be the transformational president Colin Powell predicted. If I'm wrong, we will see the rising taxes and increased protectionism promised during the campaign. 
Q. In hindsight, if you had the opportunity to alter your investment strategy for the past year, what would you have done differently?

A. I would have moved more aggressively into cash; the credit crunch has turned out to be much worse than I anticipated.
Q. Are there any sectors or areas of the globe that you would advise investors to avoid over the next year?

A. Avoid emerging markets and commodity-producing nations and companies, which are in the eye of the hurricane of the credit market collapse. But they will be major opportunities when the global economy comes back. Also avoid small-cap US companies because they are the companies having trouble getting working capital from banks.

In summary, investors should remember that although we are in a difficult economic period, the best companies in the world are on sale today for a fraction of their underlying value. Don't let the headlines keep you from capturing the gains over the next five years.

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